Broken bonds: The role Wall Street played in wiping out Puerto Ricans' savings

Spoiler:

When residents of Puerto Rico funneled their life savings into funds that were largely made up of the island's bonds, they were told their money would be safe.

They were told that they would receive interest payments that were higher than many comparable opportunities. They were told income would be tax exempt.

And when those investments began to evaporate four years ago, they were told not to sell, that the market would rebound, and they would recoup their losses — eventually.

This year, eventually became never after Puerto Rico triggered bankruptcy-like proceedings, and the island began restructuring its debt to seek protection from creditors — pushing the already depreciated bond prices within the funds lower. Then came Hurricane Maria, and those prices plummeted even further.

While the storm that decimated the island's infrastructure was unavoidable, the one that tore through the savings of its residents was entirely man-made.

"To have this type of carnage being born on this small of a population in this small of a geographic territory is something that we'll likely never see again," said attorney Jeffrey Erez, who has filed hundreds of securities cases on behalf of Puerto Rican investors. "You have the complete investing class on a very small island having lost 50 percent, 60 percent, 70 percent, 80 percent of their retirement savings within a few years."

A CNBC investigation found that UBS was not forthcoming about the extent of the risks of those bond funds from both its clients and brokers, even as the values of the funds plummeted. By the end of 2012, more than $10 billion in assets were invested in UBS' bond funds. That represented about 10 percent of the island's gross domestic product at the time. Today, those investments have been nearly wiped out.

About 2,000 pages of confidential documents obtained by CNBC reveal the inner workings and dialogue between executives at UBS Puerto Rico and those in Weehawken, New Jersey, leading up to and after the crash of the funds.

They show UBS executives sought to withhold stress-test results from their brokers and did not translate research reports and other fund documents to Spanish. They show that even though some of the most powerful brokers expressed multiple concerns about the bond funds early on, UBS management encouraged them to sell the funds anyway.

The documents also reveal that in 2012, more than a year before the eventual collapse of the funds, UBS executives in the Americas and Puerto Rico were not only aware of the funds' troubling features, they were having discussions about the devastating consequences if the firm didn't address these issues.

'There's no hope'
Gervasio Garcia Rodriguez, 76, saw losses first hand. Along with wife Maria, 73, her brother Miguel Castro Arroyo, 72, and two other relatives, they invested their life savings into funds created by UBS. Today, they say those investments have dropped about 80 percent in value, with the family collectively losing about $2 million.

"There is hope but not for us. There's no hope," said Garcia, a retired history professor who taught at the University of Puerto Rico. "In this situation, what are we going to do now? It's sad. Very sad."

The family used the dividends from the funds to pay for Maria's and Miguel's 97-year-old mother's health care and fund their own retirement.

Gervasio Garcia Rodriguez, 76. With his wife, Maria, and part of her family, Rodriguez has filed a claim against UBS Puerto Rico to try to recoup their nearly $2 million in losses.
CNBC
Gervasio Garcia Rodriguez, 76. With his wife, Maria, and part of her family, Rodriguez has filed a claim against UBS Puerto Rico to try to recoup their nearly $2 million in losses.
Seeking to recoup some of their losses, the family filed an arbitration claim against UBS for — among other counts — breach of fiduciary duty, negligence and fraud.

UBS, in an answer to the complaint, called the family's allegations "meritless" and said that the funds declined in value due to "various market forces," which did not make them "unsuitable."

More than 2,000 similar arbitration cases have been filed against UBS and other broker-dealers, including Santander Securities, Popular Securities and Merrill Lynch. UBS had disproportionately more litigation because the firm had at one point about half of the island's market share.

According to data compiled by Securities Litigation & Consulting Group (SLCG), more than $329 million in settlements and awards have been paid to clients in the four years ended Oct. 10. More than 90 percent has come from UBS, due to its proprietary closed-end funds.

For the income from the funds to be tax-free, the funds were composed of at least 67 percent in Puerto Rico-related securities. Some were upward of 95 percent.

Due to a loophole in a 77-year-old piece of U.S. legislation, none of these funds was regulated by the Securities and Exchange Commission, which meant they were not bound to as strict a leverage standard or traded on a public exchange. The Investment Company Act of 1940 allowed funds offered outside the United States, in this case the U.S. territory of Puerto Rico, to avoid certain restrictions. (For more on this loophole.)

This legal loophole "allows for the funds to engage in some affiliated party transactions that would not be allowed here on the mainland. And it allows them to be more highly leveraged," said Craig McCann, SLCG's founder and principal.

The funds were lucrative for the firm, producing more than $150 million in revenue to UBS Puerto Rico, between early 2009 and mid-2013, according to a Financial Industry Regulatory Authority (FINRA) settlement.

"I've likened it, in my mind, to a drug dealer, supplying a drug to its client that they know is not good for them, but they keep doing it anyway to enrich themselves," said Erez, who's representing the family in the claim against UBS.

In response to CNBC inquiries about the funds and claims against the firm, a UBS spokesman said there were "multiple written disclosures setting out in plain language the risks associated with Puerto Rico closed-end funds, including the use and risks of leverage in the Funds, the possibility that they could become illiquid, and that their concentration in Puerto Rican securities made them sensitive to changes in the Puerto Rico economy."

'Quit whining'
Switzerland-based UBS, which is one of the world's largest banks and oversees more than $913 billion in total assets, had rebounded from its own near-death experience during the financial crisis. It was imperative that the firm seek to keep the risky bond funds off of its own balance sheet, said McCann.

In the spring of 2011, brokers and financial advisors started receiving an influx of calls from investors because the prices of the bond funds had declined. Their clients wanted to sell and there were few buyers on the other line.

Ramon Almonte, one of the top financial advisors at UBS Puerto Rico, met with brokers on May 31, 2011, outside of San Juan to discuss key worries surrounding the funds.

An email sent to Almonte the next day that's been translated into English shows a detailed list of 22 concerns that the brokers had, including "lack of liquidity," "excessive leverage," "price instability," "excessive supply," "geographic concentration" and "churning."

Days later, UBS Puerto Rico Chairman Miguel Ferrer corralled the brokers into a meeting. He urged them to focus on the "funds' attractive benefits" and sell the product or "find another job," according to a certified English translation of a transcript from the meeting obtained by CNBC.

The lecture from Ferrer, according to the translation, was laced with profanities that ordered the brokers to "quit that whining." Ferrer told the brokers not to focus on the 22 concerns, but rather come up with a list of three or four positive selling points for the funds, including their "current yield of over seven and a half" percent, "diversification" and "exceptional" past performance.

"Next week we'll launch a campaign with these numbers in the paper," he said. "I hope the public will c-m in their pants because of that. They're f------ awesome."

Almonte, who has about 150 customer complaints listed on his public broker profile, also spoke at this meeting. He urged the brokers to "educate the client that what is happening in our economy is not necessarily linked to Puerto Rico's fiscal situation."

"Therefore, Puerto Rico's credit is good," he said. "We are the only place, the only pocket where there is money for our clients."

Almonte's BrokerCheck report shows he is still employed by UBS. Ferrer is no longer with the firm and declined to comment on this story through his counsel. The audio from that meeting was first obtained and reported on by Reuters in 2015.

Alarm bells, but not in Puerto Rico
Less than a year later, it became clearer — even to UBS — that Puerto Rico's credit was deteriorating.

The bank in a research report in January 2012 identified major risks for investors holding the commonwealth's debt including the "slower than anticipated recovery" and "rising debt burden." The 45-page report recommended: "conservative investors with concentrated exposure to any single borrower in the municipal market should pursue portfolio diversification."

A team of brokers from Puerto Rico sought to disguise some of these risks from their clients on the island, according to internal UBS emails reviewed by CNBC.

One of them showed that a group of UBS Puerto Rico brokers met with top executives in New York and New Jersey in mid-2012. An email sent on behalf of a group of brokers to Carlos Ubinas, who was CEO of UBS Puerto Rico at the time, read that they were pleased that "future research reports that address Puerto Rico bonds will bear a disclosure note stating that the content contained therein is not applicable to island residents."

However, the disclosure discussed did not appear in any of the reports reviewed by CNBC.

When questioned in 2015 in a FINRA arbitration proceeding about the UBS research reports issued in 2012 and 2013 Ubinas stated, while under oath, that although the reports were "of general applicability to Puerto Rico residents, they were mainly addressed to stateside investors holding Puerto Rico bonds."

Miguel Ferrer, former UBS Puerto Rico chairman (l), Ramon Almonte, UBS Puerto Rico financial advisor (c), and Carlos Ubinas, president and chairman of the broker-dealer and the trust company.
Source: UBS
Miguel Ferrer, former UBS Puerto Rico chairman (l), Ramon Almonte, UBS Puerto Rico financial advisor (c), and Carlos Ubinas, president and chairman of the broker-dealer and the trust company.
Furthermore, UBS never translated this report, or any of its Puerto Rico-related reports from English to Spanish, according to sworn testimony by Ubinas. This despite the fact that a large majority of Puerto Rico residents do not speak English fluently. Fund prospectuses, as well as quarterly and annual reports, also were never translated.

Ubinas, in his testimony, contends that the eventual crash of the funds was a "black-swan event" — which by definition is extremely difficult to predict.

"Concerns about the Puerto Rico economy and its prospects had been the subject of wide public debate and press coverage for many years," a spokesman for UBS said in a written statement. "But no ratings agency or analysts predicted anything like the precipitous drop in bond prices that occurred in August and September 2013."

All the way to the top
Throughout 2012, discussions over some of the funds' more troubling features rose all the way to top executives at UBS Americas, more than 1,600 miles away in Weehawken.

One email chain shows that Robert Mulholland — who was the head of UBS wealth management Americas client advisory group — was having trepidations about the excessive leverage in the UBS funds as early as April 2012.

Almonte wrote back to Mulholland to argue it was not time to dial back the funds' leverage.

"This is not the time to deemphasize the importance of our very successful business model," Almonte wrote, "any reduction in credit lines, margin limits, haircut, etc. can unfold into an undeserving loss of clients, assets and brokers to even more aggressive competitors.

"Of equal importance is the need attend to investment advisors' concerns in such a way that we can again unite to stop asset outflows and increase profitability."

Mulholland, who reported directly to Robert McCann, the CEO of UBS Americas at that time (unrelated to Craig McCann of SLCG), was not only fully aware of the issue but knew the consequences if the firm didn't dial back leverage.

"I have seen firm's over aggressive use of leverage in their business model ruin the firm (Merrill Lynch/Bear Stearns/Lehman). I will not let that happen to UBS PR," he wrote. "I don't want to risk client losses and business losses when rates turn up. And, unfortunately, the losses are usually rapid due to illiquidity. I believe we are helping preserve clients' portfolios by moderating (not eliminating) leverage now vs. extending more."

Mulholland predicted in that April 2012 email the catastrophic outcome that would take place more than a year later. Mulholland left the firm in 2015 and did not respond to requests for comment.

Moody's knocks bonds to almost junk
By the end of 2012, Moody's Investors Service cut the rating of the island's bonds to just above junk status, citing a weak economic recovery, very high levels of debt and a shrinking population.

The day of the downgrade, a flurry of internal emails was sent to and from executives at UBS Puerto Rico and UBS Americas questioning how this would impact the funds. It caught the attention Robert McCann. One email showed that the results of a stress analysis on how the downgrade would impact the firm's balance sheet were delivered directly to McCann.

At the end of the year, Ferrer tried to assuage any fears over the downgrade, sending an email on Dec. 18, 2012, to a financial advisors' distribution saying: "My own impression is that over a few months, prices will be firmer and today's bad news will be yesterday's news. For some, today's prices may offer a buying opportunity."

But research on Puerto Rico became increasingly negative throughout 2013. In March, after a downgrade by S&P, a UBS report warned that "Puerto Rico's reliance on periodic financial restructurings to balance its budget in the past [i]s a principal risk for investors." And it further recommended "investors diversify their holdings in favor of stateside issuers."

The brokers became increasingly concerned.

In April of that year, financial advisors at UBS Puerto Rico requested a "risk analysis of the total Puerto Rico bonds held on margin so they could understand the worst and probable scenarios," according to an email from Ferrer to Mulholland and Ubinas.

Mulholland responded the following day, April 11, 2013: "We will not print and give them our stress analysis ... we don't want it going public."

The next day Mulholland reiterated his decision in an email to Ferrer saying the request "is absurd and you should know that."

Detroit's bankruptcy in July 2013 was a "watershed event with implications that reverberated throughout the entire market," according to an October 2013 Morningstar special report. It also drew more attention to the island's liquidity and financial troubles and sparked warnings that Puerto Rico could be "the next Detroit," and investors "began looking around to see what might be the next shoe to drop."

These fears worsened as Puerto Rico's growth slowed. By late August 2013, investors in the UBS funds started to notice significant losses in their accounts.

"Until the sudden market disruption in 2013, Puerto Rico bonds were the top performer in the municipal market in the first half of 2013," UBS' spokesman said in the statement. "There were no undisclosed issues with the Funds."

Massive sell-off
The losses that August were unfortunately nothing compared with what was about to unfold.

In September 2013, numerous factors including growing fiscal concerns, increased headline risk and financial institutions selling large blocks of Puerto Rican bonds, all came together and resulted in a massive sell-off that further depreciated the value of the UBS funds. By the end of 2013, the UBS closed-end funds had lost $3 billion in value, or nearly 70 percent, in that year alone, SLCG data show.

As a result, UBS had to sell some of the assets within its proprietary funds because the prices of the underlying bonds fell to levels that violated the maximum leverage requirement. This caused a forced liquidation for the UBS funds.

It also resulted in permanent losses in the funds, which Ubinas says in his testimony will never be recovered.

"It becomes a vicious cycle because you have to sell, you're selling into a bad market, prices come down, which creates another sort of margin call, which creates another problem, and then it's like a vortex," Ubinas said in his 2015 testimony. "What kills you is how quickly it happens, because if it happens slowly over time, you can manage it. If it happens: Boom. All you have are dead bodies."

Eliezer Aldarondo, whose Puerto Rico-based law firm partnered with Erez in August 2013, also noted in an interview that the UBS funds have been largely illiquid since mid-2016 — meaning that even if an investor's statement shows money in the account, the investor isn't able to access those funds since there are no buyers in the market.

Eliezer A. Aldarondo of Puerto Rico-based law firm Aldarondo & Lopez-Bras. He represents Gervasio, Maria and Miguel.
CNBC
Eliezer A. Aldarondo of Puerto Rico-based law firm Aldarondo & Lopez-Bras. He represents Gervasio, Maria and Miguel.
Client statements from November 2017 show several UBS closed-end funds, which were purchased around $10 a share, have fallen below $2 per share, with one trading as low as $1.25 per share.

Analysts say that what happened to investors in the closed-end bond funds is a precursor for investors who hold the individual bonds.

Losses have accelerated on the outright bonds this year. The first blow was in May, following the commonwealth initiating the largest bankruptcy-like proceedings in the history of the U.S. municipal bond market.

Then in October, in the aftermath of Hurricane Maria, which devastated the island, bond prices plunged. Securities litigation has increased in the past year against the main broker-dealers in Puerto Rico that sold the outright bonds, namely Santander and Banco Popular, according to SLCG analysis.

DOJ launches criminal probe
In addition to the tsunami of arbitration, UBS has paid more than $65 million in settlements with regulators over sales practices for the Puerto Rico bond funds.

The firm settled with the SEC in 2012 for $26.6 million and in 2015 for $15 million. Also in 2015, UBS settled with FINRA, the industry's self-policing regulatory agency, for $18.5 million. A year prior, in 2014, UBS settled with Puerto Rico's local regulator, the Office of the Commissioner of Financial Institutions, for $5.2 million.

The regulators' charges included that the firm misrepresented and omitted material facts about the closed-end bond funds to investors and failed to monitor the combination of leverage and concentration levels in customer accounts, according to the settlement documents.

UBS Puerto Rico did not admit or deny wrongdoing in any of the settlements.

In October 2013, in a decision "in favor of two UBS executives facing SEC civil charges, the SEC's Chief Administrative Law Judge concluded that UBS's disclosures about the [closed-end funds] were accurate," the firm's spokesman points out in a statement.

UBS has disclosed in regulatory filings that the Department of Justice is conducting a criminal inquiry into the impermissible reinvestment of the nonpurpose loan proceeds, in regard to the Puerto Rico funds. "We are cooperating with the authorities in this inquiry," the filing states.

Brokers fight back
At least 10 former UBS brokers are also in litigation against their former employer, claiming that the firm declined to share important details about the bond funds that subsequently caused their clients harm, based on arbitration filings reviewed by CNBC. Now, the brokers say, their reputations are ruined.

Jorge and Teresa Bravo were a brother-sister team who sold the bond funds to 200 of their clients. After only three years at UBS, the Bravos each now have more than a dozen customer complaints.

"It's basically a disaster, because right now, clients blame you," Jorge Bravo told CNBC. "Your personal life's almost gone; you have the stress of litigations that are pending on your cases. ... Everything is going bad."

In their arbitration claim against UBS, the Bravos said that "to artificially preserve the market, UBS made material misstatements and omissions to both brokers and customers about the PR funds, UBS's true analysis of the PR Funds and the market they controlled."

Jenice Malecki, founder of Malecki Law. She represents Teresa and Jorge Bravo.
CNBC
Jenice Malecki, founder of Malecki Law. She represents Teresa and Jorge Bravo.
"One of the worst victims in the entire process is the broker," said Jenice Malecki, who represents the Bravos in their case against UBS. "The brokers lose everything. They lose their careers. They lose their reputations. They lose their friends and some of them, even family."

Teresa Bravo had also purchased $100,000 worth of the Puerto Rico funds for her personal brokerage account. She was able to sell out of her position in April 2013, before funds became illiquid. She said she still suffered losses.

The Bravos also advised their friends and family, including their brothers, to buy the bond funds.

"They know that we tried to do our best. But it was the funds that exploded," Jorge Bravo said.

UBS turns up pressure on the brokers
In the fall of 2014, in wake of the Puerto Rico fund implosion as investors in the bond funds were reeling from the major losses in their portfolios, UBS instituted a "Performance Improvement Plan" for their brokers.

According to their claim, the Bravos were told to accomplish at least one of three requirements within three months or they would be terminated: increase their production by 10 percent, bring in $500,000 in new assets and boost the percentage of assets they manage by 0.5 percent to 1 percent.

Jorge and Teresa Bravo, former brokers at UBS Puerto Rico, have filed a claim against the firm.
CNBC
Jorge and Teresa Bravo, former brokers at UBS Puerto Rico, have filed a claim against the firm.
This ended up creating "a high pressure environment to induce brokers, including the Bravos, to find more assets and sell the PR Fund products, or else face termination," the claim details.

In reality, "the Plan meant, either churn your client['s] account to increase production or pull in $1 million more assets and sell more clients toxic PR Funds."

The Bravos say this was the final straw. They both resigned Jan. 30, 2015.

"UBS lost the clients' lifetime savings … 50 percent, 60 percent, 80 percent of their clients' money. And now you're going back to the client and say … 'UBS is telling me I need to generate 10 percent more of commissions.' That's absolutely immoral," Jorge Bravo said.

"As a result of UBS's wrongful conduct, the Bravos were forced to resign and constructively terminated," the claim states.

"The brokers are kept in the blind and can provide no answers," their resignation letter said. "The undersigned feel oppressed and harassed by UBS NY's Management directives, regarding the haste efforts for risk and loss control through unreasonable demands upon brokers, willfully destruction of Teams and undue pressures upon brokers as to matters which the clients' may well have a right [to] know for their own assessment."

UBS claims that "the Bravos voluntarily resigned from UBS in 2015 to join a competitor," the firm's spokesman wrote in his statement to CNBC.

Following their departure from the firm, UBS contacted the Bravos seeking to recover the approximately $1.6 million — $800,000 remaining for each of them — that "was given to them as an upfront bonus and two subsequent production bonuses, in the form of forgivable loans," their claim alleges.

"During their brief tenure at UBS, the Bravos received more than $1.6 million in loans from UBS, which they have refused to pay back. The arbitration claim they have filed seeks to cancel that lawful debt. Any comments they make now should be viewed in light of their obvious financial incentives," the UBS spokesman said.

In addition to trying to cancel the debt the Bravos are seeking relief in the amount of no less than $10 million and are also seeking punitive damages due to "the extreme and outrageous conduct with which the Bravos and other brokers at UBS were treated by UBS [that] crossed the bounds of decency to be regarded as atrocious and intolerable in a civilized society," the claim states.

The Bravos admit they share some of the blame. Jorge said his biggest mistake was, "believing in UBS management, believing that they were telling me 100 percent of the facts, believing that they were protecting our clients' assets, believing that this was gonna be the best for the clients."

"But now, I see that, of course, I didn't have the information," he said.

Financial losses deepen after Hurricane Maria
After Hurricane Maria struck in September, more than 472,000 housing units were destroyed or severely damaged. The agriculture sector was decimated, including the loss of almost 80 percent of planted crops. Meanwhile, the electrical grid was destroyed leaving parts of the island without power for months.

Damaged trees from Hurricane Maria in Old San Juan, Puerto Rico.
CNBC
Damaged trees from Hurricane Maria in Old San Juan, Puerto Rico.
The slow pace of recovery had been weighing on the financially strapped island, which had already been suffering under the weight of a recession lasting more than a decade.

Miguel and Maria's mother, Angelica, who lives with Maria and Gervasio and requires 24-hour care, fell ill after the hurricane hit. The family was unable to call a doctor for help due to the island's telecommunications systems being wiped out by the storm.

A friend was able to provide antibiotics, which allowed Angelica to recover from the infection.

"Everything is hard for us," said Maria, who has lived in Puerto Rico her whole life. "You feel that you can't do anything, that everything is out of your hands."

Repair from the storm is likely to be one of the most expensive ever. Puerto Rico Gov. Ricardo Rossello has requested a $94 billion aid package but the U.S. government has not approved it yet.

In October, President Donald Trump said in an interview with Fox News that the island's debt should be wiped out.

Those comments sent the value of the bonds plummeting even further. The benchmark general-obligation bonds maturing in 2035 have plunged more than 60 percent since Hurricane Maria made landfall. They now trade around 20 cents on the dollar.

And erasing the debt completely would be catastrophic for the thousands of Puerto Rico residents who own the commonwealth's bonds in their retirement accounts. Gervasio and Maria Garcia and her brother Miguel Castro, who were already grappling with $2 million in losses, are seeing their finances even more strained since the hurricane.

Fearing for his mother's life after the generator ran out of fuel, Castro stopped in the middle of the road to beg a fuel truck driver to follow him to the house.

Miguel Castro Arroyo, 72. Maria’s brother and part of the family that has filed a claim against UBS Puerto Rico to try to recoup their nearly $2 million in losses.
CNBC
Miguel Castro Arroyo, 72. Maria’s brother and part of the family that has filed a claim against UBS Puerto Rico to try to recoup their nearly $2 million in losses.
Between the fuel and the extra tip money for the drivers, it's costing the family around $500 per week just to keep the lights on for their mother.

Nearly three months after the hurricane hit, the family is still without power and the generator they had been using recently broke. The cost to replace the broken generator was $6,000.

"We are conservative people; we tried to invest in something with no risk," said Castro. "Can you imagine working for over 40 years and trusting your savings to a person, to a company, and the value [of those savings] today is trash?"

UBS settled with Miguel, Maria, Gervasio and the other family members more than a year and a half after the initial claim was filed, according to the lawyer for the family. Terms of the settlement, which are confidential, were reached late Friday, Dec. 15. That was just two days before the case was scheduled to be heard by a FINRA arbitration panel and three days before this story's publication and airing on CNBC.

"We are pleased that our clients were able to resolve this case without the necessity of having to continue the arbitration. Our clients are very satisfied with the outcome," Erez said.

This week, financially destitute Puerto Rico made two big moves seemingly aimed at lowering expectations that the commonwealth will be able to function as a government any time this decade.

On Monday, Gov. Ricardo Rossello announced plans to sell the island’s troubled public power company to the private sector. It was devastated by Hurricane Maria, which in late September knocked out power across the entire island and left 3.4 million residents in the dark. Today, four months later, more than one-third of homes and businesses are still without electricity.

Two days after making the announcement, the governor lowered the bar even further. He warned that the physical damage and population exodus following Maria meant that Puerto Rico might not be able to pay back even a portion of the $74 billion in bond debt that forced the government into bankruptcy.

The Takeaway: It wasn’t too long ago that Rossello’s predecessor, Gov. Alejandro Garcia Padilla, told a group of reporters that Puerto Rico might be able to return to the municipal bond market after two years. At the time, Congress had just passed a rescue bill that gave the government -- a frequent seller in the bond market -- a path to bankruptcy and a way to restructure its debts.

Still, that statement seems laughably optimistic in retrospect. While no one could have predicted the blow that Hurricane Maria would deliver to the island’s fiscal recovery, bondholders were already complaining about the restructuring process. Investors were concerned the fiscal recovery plan was light on details, notes Municipal Market Analytics’ Matt Fabian in his weekly report. Even now, he adds, the “commonwealth still cannot show the regular cost of its basic operations and how that money is being spent.”

Given these conditions, the government’s moves to absolve itself of more debt obligations will certainly invite scorn from bondholders and likely shut itself off from any kind of municipal market borrowing for the foreseeable future.

Puerto Rico Governor Ricardo Rossello said the government’s ability to pay even a fraction of its debts was reduced by the crippling blow of Hurricane Maria, which has caused tens of thousands of residents to leave and pushed the economy into a deep contraction.

The governor’s comments to reporters in San Juan came ahead of a revised fiscal plan that the bankrupt commonwealth is set to submit to its federal oversight board. Skipping debt payments outright would save the U.S. territory hundreds of millions of dollars a year compared with what it had been prepared to pay before the storm, freeing up cash for rebuilding and allowing it to avoid deeper budget cuts that could further impede its recovery.

Ricardo RosselloPhotographer: Kevin Dietsch/Pool via Bloomberg
“We had to consider the significant social impact that Maria caused, due to the massive exodus that we’ve had and are expected to have in the future,” Rossello told reporters Wednesday in San Juan.

The comments underscore the deep losses facing owners of Puerto Rico’s $74 billion of bonds, whose prices have tumbled since the Sept. 20 hurricane amid widespread expectation that even more of the government’s obligations will need to be written off in bankruptcy. The blueprint, if approved by the federal overseers, will serve as a basis for negotiations with bondholders.

The new fiscal plan comes as island officials estimate its gross national product will contract deeply in the year ending in June, officials told reporters today in San Juan. That’s expected to reverse next year with the help of federal disaster funds and rebuilding after Hurricane Maria.

The September storm, which destroyed much of the island’s electricity system, cut into tax collections and prompted many residents to flee to the U.S. mainland, exaggerating the financial drain that had already pushed it to the brink. A lawyer for the federal control board last year said in a court hearing that a five-year moratorium may be needed, given the severity of the disaster it’s facing.

While the administration believes Puerto Rico is unable to pay bondholders, the federal board will lead negotiations with creditors and the bankruptcy court will decide the ultimate payments, Rossello told reporters.

Puerto Rico began defaulting on its bonds in 2015, unable to repay what it owed after years of losing residents. It filed for bankruptcy in May after the U.S. enacted an emergency rescue law that gave it power to do so and installed the federal board to help the commonwealth’s government chart a financial turnaround.

Puerto Rico’s original recovery plan said it could allocate $8 billion for debt payments through 2026, far less than the $33.4 billion that’s owed. The government’s payments under that plan would have amounted to $3.7 billion through 2022, a period when $17.1 billion of principal and interest is set to come due.

Puerto Rico has yet to detail how any losses would be distributed among various classes of bonds backed by different legal pledges and with sometimes competing claims to the government’s cash. Groups of creditors are currently fighting over that issue in court.

Prices on most commonwealth securities have tumbled over the past two months. General obligations with an 8 percent coupon and maturing in 2035 traded Wednesday for an average of 26 cents on the dollar, down from as much as 59 cents in September, before the storm. Some bonds trade for even less, with those issued by the infrastructure and highway agencies going for pennies on the dollar.

Puerto Rico unveils revised fiscal plan: No debt service payments for the next 5 years
The new plan sees zero debt service payments over the next five years.
It also lays out the initial process for the privatization of the island's beleaguered power utility.
The previous plan covered a 10-year period and allocated around $787 million per year for debt service payments.

Spoiler:

Puerto Rico Governor Ricardo Rossello submitted a revised fiscal plan for the bankrupt island which sees zero debt service payments over the next five years, and lays out the initial process for the privatization of the island's beleaguered power utility.

The previous fiscal plan, which was certified by the federally appointed oversight board in March 2017, covered a 10-year period and allocated around $787 million per year for debt service payments. That amounted to less than a quarter of the $3.5 billion owed to creditors every year.

After the destruction of Hurricane Maria, it was decided that the fiscal plan needed to be revised to reflect the new reality the already cash-strapped island was facing. The revised fiscal plan for Puerto Rico's central government covers a reduced time frame of five years and allocates nothing to creditors, while guaranteeing retirement pensions.

An addition to the revised fiscal plan is an expense for Title III proceedings, which is the bankruptcy-like that a federal judge is currently overseeing for the island's outstanding bond indebtedness of roughly $73 billion, or nearly $17,000 debt per capita.

Moody's Investors Services notes that specific bondholder recoveries "will likely emerge after judicial proceedings or negotiations, and would be determined by economic projections and relative strengths of bondholder claims," said Ted Hampton, VP and Senior Credit Officer at Moody's.

The Commonwealth expects expenses for its government to increase over the five-year period, while projecting a cumulative decline in population of 19.4 percent over the same time period.

The plan also includes an injection of $35.3 billion in federal aid from FEMA, although it anticipates receiving "significantly more" and has previously requested $94.4 billion in Federal Disaster Relief Assistance.

Approximately 51 percent of that federal aid is intended to be allocated to repair, modernize and strengthen the island's crumbling water and power infrastructure.

However, even after all government transformation initiatives and structural reforms are implemented, Puerto Rico still foresees have a funding gap of $3.4 billion through fiscal 2022. As a result, the island's government believes a liquidity facility will be needed to bridge the gap.

PREPA's revised plan
Puerto Rico's Electric Power Authority (or "PREPA") is one of the largest public power utilities in the US, serving 1.5 million customers with total revenues of $3.4 billion, total assets of $9.4 billion and total liabilities of $11.4 billion in fiscal 2017.

A key challenge highlighted in the fiscal plan is that a significant amount of emergency federal funding is needed to alleviate PREPA's immediate liquidity shortfalls. The plan sees three buckets of funding as options: Community Disaster Loans (or "CDL") from the U.S. Treasury, FEMA Emergency Funding Commonwealth Bridge loans to cover essential current and near-term government functions in advance of receiving a CDL.

The governor's intended transformational plan for PREPA, which he announced on Monday, was included in the fiscal plan.

PREPA's transformation assumes that the utility will cease to operate in its current from in the next 18-months with the island aiming to sell the existing PREPA generation assets to private investors. It also includes development of new generation and a concession model for the power transmission and distribution (or "T&D") system (for example, the system would still be owned by the Government of Puerto Rico, but would have a private operator).

The terms of concession are listed as "to be determined, but likely medium to long-term," with the concessionaire having the right to collect all revenues, and the responsibility to pay all costs, generated by the T&D system.

Rep. Rob Bishop, R-UT, the chairman of the House Natural Resources Committee and key figure in crafting PROMESA, called for full transparency in the PREPA transformation process, saying it "cannot be done behind closed doors."

"It is imperative the Oversight Board and Governor fully integrate those who hold the debt into the development of these plans, thereby guaranteeing accuracy and transparency in the underlying assumptions," Bishop said in a statement issued Thursday.

Bishop also weighed in on what he views as a legal necessity for PREPA's fiscal plan.

"The Board's stated goal under PROMESA is to return Puerto Rico to fiscal accountability and the capital markets, and this can only occur if the fiscal plans respect the lawful priorities and liens of debt holders," he said.

A sentiment echoed by Assured Guaranty, which has approximately $853 million of net par exposure to PREPA's debt as of Sept. 30, 2017.

The insurer issued a strongly worded statement on Tuesday night that urged any potential privatization partners or investors to look at if the Commonwealth's plan adheres to the laws set by PROMESA and the U.S. Constitution.

"The system cannot be sold free and clear of the lien on revenues unless the lien is discharged through full payment of the bonds, there is adequate coverage of debt service after any sale of assets, or the bonds are given the full value of their collateral through a confirmed plan of adjustment," the insurer said in the statement.

PREPA's bonds are secured by a lien on the electric utility system revenues, and are further supported by covenants and Puerto Rico law that ensure the electricity rates are sufficient to cover all costs including debt service.

The plan to privatize also sparked concerns with a separate group of PREPA creditors which hold around $3.3 billion of PREPA's bonds.

"We believe the only path for any proposal to deliver low cost and reliable power will be if it respects property rights, since failure to do so will result in years of litigation from multiple parties," a written statement issued on Monday by the Ad Hoc Group of Bondholders said. The group includes hedge funds BlueMountain Capital and Marathon Asset Management, as well as mutual funds OppenheimerFunds and Franklin Advisers.

The federally appointed Oversight Board confirmed receipt of the Fiscal Plans for the Commonwealth, PREPA and also for PRASA, the aqueduct and sewer authority.

"The Oversight Board views implementing structural reforms and investing in critical infrastructure as key to restoring economic growth and increasing confidence of residents and businesses," said Natalie Jaresko, Executive Director of the Oversight Board in a statement issued Thursday.

The Oversight Board is holding a listening session to receive testimony from experts and stakeholders on the future of Puerto Rico's energy sector next Thursday in New York. The Board also intends to proceed with its evaluation of the three fiscal plans and hopes to certify them by February 23rd.

Assets of the Puerto Rico Electric Power Authority, the largest U.S. public power provider, could reap as much as $4 billion, Governor Ricardo Rossello said Wednesday.

The governor is seeking to place the bankrupt utility into private hands. He’s heard from some “people” that such a move could garner $2 billion to $4 billion, although those figures aren’t an asking price or an official valuation, Rossello told reporters Wednesday in San Juan after speaking at a conference on Puerto Rico’s economic future.

The governor announced this month his plan to privatize Prepa, as the utility is known, after Hurricane Maria slammed into the island in September and destroyed its power grid. About 500,000 customers are still without electricity and the system is generating at 81 percent of its capacity, as of Tuesday.

Rossello announced Wednesday a working group that will collaborate with Puerto Rico’s federal oversight board on Prepa’s privatization. That working group includes Christian Sobrino, the governor’s representative on the federal board; Maria Palou, Rossello’s infrastructure adviser; Todd Filsinger, Prepa’s chief financial adviser, and Rothschild & Co., the commonwealth’s restructuring adviser.

Jose Carrion, chairman of the federal board, reiterated the panel’s support in privatizing Prepa.

“The clearest thing that Irma and Maria showed us was that the Puerto Rican energy system doesn’t work,” Carrion said at the conference in San Juan. “And what doesn’t work should be changed.”

Industry Regulator?
Carrion said the board and government had initial differences of opinion on the legal framework around the privatization. In particular, the board wants any industry regulator to be independent, he said, adding that the government had been "receptive" to the idea.

Prepa, which has more customers than any other U.S. public power utility, had challenges before Maria. Its generation system is 28 years older than the industry average after years of mismanagement and neglect. It relies on oil to produce electricity, which increases costs for consumers and pollutes the island. Prepa fell into bankruptcy last year after the federal oversight board rejected a $9 billion restructuring deal.

Puerto Rico expects to present a legal framework for a Prepa privatization by the summer, Rossello said. The utility has $100 million of liquidity and is waiting for a judge to approve a $550 million loan from the commonwealth government.

The potential privatization would involve Puerto Rico retaining ownership of Prepa’s transmission and distribution system, but a private operator would manage and run it for a period of years through a concession agreement, according to Prepa’s revised fiscal plan. The utility would sell some existing generation assets to private investors or possibly retire some plants. Puerto Rico would build new generation assets through public private partnerships.

The goal is for electricity rates to be below 20 cents per kilowatt hour, Rossello said.

Prices on commonwealth debt have fallen since the storm. Prepa bonds maturing in 2037 traded Wednesday at an average 33.5 cents on the dollar, down from an average 56.6 cents in September, according to data compiled by Bloomberg.

According to a Bloomberg report, Puerto Rico officials recently unveiled a summary of account balances for the debt-ridden territory's various agencies and touted a push for more transparency, amid heightened scrutiny over the recent discovery of nearly $7 billion in undisclosed funds stashed in government bank accounts.

Facing a panel of financial professionals appointed by the U.S. government to oversee Puerto Rico’s landmark debt overhaul, the head of the territory’s fiscal advisory agency said that his team is hard at work to improve controls over governmental cash flow, address real liquidity challenges and improve transparency.

Forced to address concerns that the commonwealth is economically better off than it has let on, the agency’s executive director Gerardo Portela presented a report with recent cash balances for the government and its instrumentalities that are held in more than 800 bank accounts.

Portela, who acknowledged that there is work to be done to improve the local government’s accounting practices, said that although the recent cash revelations raised eyebrows, the island’s liquidity problems are genuine, according to Bloomberg.

In a recent letter sent to Portela’s office, the U.S. government also cited the recently published bank accounts, as well as a $1.7 billion commonwealth cash balance, as reasons for the Federal Emergency Management Agency to hold off on releasing community disaster loans to the territory’s government in response to the devastation caused by Hurricane Maria.

Because such money was available, the federal government will distribute the loans when Puerto Rico’s funds fall below a certain level, which will be determined by federal officials, according to the letter.

Puerto Rico is struggling to rebuild its infrastructure from the devastating effects of Hurricane Maria, but it also must get its fiscal house in order. Right now, it’s a mess.

Zamansky LLC is a New York law firm which represents investors in court and arbitration cases against securities brokerage firms and issuers. The firm may represent investors in cases against companies mentioned in this blog. Zamansky LLC also represents investors in arbitration cases against UBS and other brokerage firms regarding Puerto Rico bonds and UBS closed end bond funds and other investments.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

HEDGE FUND-DRIVEN AUSTERITY COULD COME BACK TO BITE THE HEDGE FUNDS DRIVING IT IN PUERTO RICO

Spoiler:

VIRTUALLY EVERY HEADLINE about the Puerto Rican government’s newly released fiscal plan has focused on its finding that the island won’t be able to pay back the vast majority of funds owed to its creditors, many of them American-based hedge and mutual funds. Even in the new plan’s rosy projections for economic growth, the island would only be able to return a small fraction of its at least $74 billion in municipal debt in the next 30 years.

But informing those growth projections is an economic doctrine that has gotten it wrong in nation after nation. The borderline religious belief in austerity holds that cutting government spending is the route to growth for struggling economies, but it generally has the opposite effect in real life.

In Puerto Rico, the approach involves a series of punishingly deep cuts to the island’s public sphere, including shuttering over two-thirds of Puerto Rican governmental bodies, closing more than 300 public schools, and putting huge swaths of the island’s public infrastructure up for sale.

“The record is unambiguous that austerity does not lead to economic growth. It leads to contraction,” Nobel Prize winner and former chief World Bank economist Joseph Stiglitz told The Intercept when asked about the plan. “What is deeply disturbing is that when you have cuts to things like health care, education, and infrastructure, that’s inevitably going to have implications for long-term economic growth.” He and 25 other economists recently released their own fiscal plan for Puerto Rico as the new official one was being drafted.

Slower growth would mean even less ability for the government to pay back its creditors.

The government plan, released last Wednesday, is intended to replace the plan approved by the Washington-appointed fiscal control board last March and respond to the damage caused by hurricanes Irma and Maria. It, too, will have to be approved by the control board, known colloquially as the “junta” on the island. Created by the PROMESA law, which was passed by Congress in the summer of 2015, that body has broad authority over economic life in Puerto Rico and is tasked with interfacing between its government and creditors.

The fiscal control board will analyze the new fiscal plan over the next several weeks and will either approve the plan, reject it, or send it back to the governor’s office for revisions. Sources close to the matter suggest a final plan could be approved as soon as March.

“Puerto Rico is a colony, but it was a colony that we said could be self-governing. Now we’ve taken away that self-governing aspect,” Stiglitz told me. “For a country like the U.S. that makes a big claim to believing in democracy, it’s pretty terrible for it to say, ‘You’re a democracy, but — by the way — the hedge funds are just as important as you are, so you may have to lose your votes.’”

As an alternative to austerity, he and the other economists call for a write-down of “most if not all” of the island’s debt and large-scale public investment, as a means of recovery from both last year’s brutal hurricane season and the over-a-decadelong recession the island had been grappling with well before the storms hit. Stiglitz emphasized that spending — expansionary fiscal policy — is especially important as Puerto Rico doesn’t have a means of changing its monetary policy, which is the same as that set for the mainland U.S. “Austerity will actually lead them to a weaker economy, what we’ve seen over and over again is that countries [where austerity is enacted] become more financially precarious,” he said, likening Puerto Rico’s situation to that of Greece, another indebted economy without a sovereign currency.

“Fiscal policy’s what you need to jumpstart the economy. Puerto Rico is in an even worse situation because one of the other peculiar features there is extreme migration to the U.S. When jobs get scarce, people leave. That makes demand even weaker, and the economy even weaker. It’s a vicious cycle,” Stiglitz noted. Estimates vary for how many have already left post-Maria, though the fiscal plan predicts a nearly 20 percent population dropoff by 2022.

“Just look around places in the U.S. where there was population exodus,” he said. “You can’t sustain public facilities or the public framework that’s necessary for a prosperous economy.”

Sitglitz and other economists argued that the government’s previous fiscal plan “did not provide for economic recovery” and adopted a number of “unrealistic assumptions,” including “an over-optimistic view of how structural reforms, such as pension and other spending cuts, or downsizing the government labor force might stimulate growth, when the most likely effect is the opposite.”

The next plan, they added, “must be fundamentally different than the previous one if Puerto Rico is to have a chance for recovery.”

It isn’t. Aside from even more bullish projections for economic growth, the government’s new draft is similar in spirit to the previous one and considerably longer — 92 pages compared to just 37 in the last version. It includes far more detailed proposals for sector-by-sector cuts and how to integrate more private sector involvement in the island’s essential services. To the chagrin of bondholders, neither the economists’ plan or the one put forward by Gov. Ricardo Rosselló’s office predict that the island will have any capacity to service its debt over the short-term; the latter suggests it won’t be until 2048 when the island could handle paying off — at most — $15 billion.

“The largest difference between this fiscal plan and our sketch is that the government and the Fiscal Control Board continue to bet on austerity and other neoliberal policies that have not worked in Puerto Rico or in most of the countries,” says José Caraballo Cueto, a University of Puerto Rico economist who signed and helped draft the alternate proposal.

Compared to the previous version, the government’s new plan premises even minimal repayment on a projected spike in the island’s gross national product. Its authors predict the GNP will swell by 7.6 percent next year, compared to the 3.4 percent drop in GNP state analysts projected several months ago. The gap will be “fueled by federal support,” they argue, alongside structural reforms to roll back government spending and create a more welcoming environment for private investment.

Asked if such projections were realistic, Caraballo Cueto told me, “No. A real (adjusted by inflation) economic growth of 7.6% in 2019 is unrealistic.” He suggested, as well, that a bill introduced late last year by Sens. Elizabeth Warren, D-Mass., and Bernie Sanders, I-Vt. —for massive federal spending on the island and debt cancellation — might be among the most realistic options for jumpstarting Puerto Rico’s economy. “I think that if Congress takes seriously their shared responsibility and approves the project of Warren and Sanders that asks for more than $146 billion for Puerto Rico, we can expect a relatively high economic growth for two years,” he said. “But not as high as 7.6 percent, and that growth will not last forever, as reconstruction probably will only take between one or two years.”

WASHINGTON, DC - DECEMBER 21: Puerto Rican Gov. Ricardo Rossello is interviewed by a TV channel after a House vote at the Capitol December 21, 2017 in Washington, DC. The House has passed a $81 billion emergency aid bill to help Texas, Florida, Puerto Rico and California to rebuild after natural disasters this year. (Photo by Alex Wong/Getty Images)
Puerto Rican Gov. Ricardo Rosselló is interviewed by a TV channel after a House vote at the Capitol on Dec. 21, 2017 in Washington, D.C. Photo: Alex Wong/Getty Images

THE GOVERNOR’S PLAN paints the 2017 hurricane season as a blessing in disguise. “The devastation caused by Hurricanes Irma and Maria creates an opportunity to redesign major components of the Island’s critical infrastructure, invest in the quality and resiliency of public and private buildings, and restructure and modernize and reevaluate delivery of services to residents,” Rosselló’s plan argues.
The scale of that proposed redesign is extraordinary. The government downsizing outlined amounts to a deconstruction of the island’s administrative state, condensing the total number of government entities from 115 to just 35.

One of the main levers for that consolidation passed through Puerto Rico’s legislature late last year. Called the New Government of Puerto Rico Act, the measure outlines ways to “address inefficiencies within the Executive Branch through a careful analysis of services offerings that will allow for externalizations and consolidations of agencies.”

In the next five years, Rosselló’s office further hopes to eliminate more than 8,000 government jobs. Toward that end, he recently unveiled a Voluntary Transition program, which incentivizes public sector employees to either retire early or seek employment in the private or nonprofit sector. The remainder are expected to leave through attrition or as their departments are liquidated.

In line with this “right-sizing” goal, as well — and that to increase the “ease of doing business” in Puerto Rico — is a proposed transformation of the island’s regulatory frameworks, including everything from shipping laws to occupational licensing. The plan further includes generous tax incentives for corporations to do business on the island and invest in both public-private partnerships. “Those kinds of supply-side measures have almost never worked,” Stiglitz said, “particularly in a small economy with the kinds of handicaps that Puerto Rico has.”

One of the key goals of the structural reforms proposed is to “reduce unnecessary regulatory burdens to reduce the drag of government on the public sector.” The first such overhaul, which also appears in the plan, has already been announced: to combine the regulators overseeing everything from telecoms to energy into one three-member body.

This is especially relevant to the government’s recently announced plan to privatize the Puerto Rico Electric Power Authority, or PREPA, the island’s public electric utility. By auctioning off parts of the utility to private bidders, the plan would leave different pieces of the utility’s operations up to different companies. If all goes according to plan, that process would happen with as little regulatory oversight as possible, leaving a slew of corporations free to set their own rules regarding everything from rates to reliability to power sourcing.

“Privatization is one of those market reforms where a lot of faith is put,” Caraballo Cueto said. “Providing the same service for a higher price is not how efficiency is defined in economics. In the case of the San Juan airport, a provision was included in the contract which says that if another airport in Puerto Rico is developed and that causes a reduction of revenues to the airport of San Juan, the government of Puerto Rico has to compensate those revenue losses. This runs against those that argue that one of the ‘advantages’ of privatization is promoting competition and a free market.”

Besides its airport and toll roads, the government’s other major experiment with privatization was carried out under Gov. Ricardo Rosselló’s father, Pedro Rosselló, who served as governor from 1992 to 1996. In 1995 he sold the Puerto Rico Aqueduct and Sewer Authority, or PRASA, to a subsidiary of the French company now known as Veolia. Prices rose and quality plummeted, with some of the worst service in the island’s poorest parts. The utility’s debt swelled, and it was fined $6.2 million by the Environmental Protection Agency for noncompliance. “Deficiencies in the maintenance, repair, administration and operation of aqueducts and sewers, and required financial reports that were either late or not submitted at all,” Puerto Rico’s comptroller office wrote in a scathing 1999 report. After being sold off again, the water utility was eventually brought back under public ownership.

Also on the chopping block in the new fiscal plan is Puerto Rico’s public education system. In addition to closing more than 300 schools by 2022, the plan would consolidate the island’s 35 school districts into seven along the same timeline, simultaneously “improving” the student teacher ratio by raising it from 11:1 to 14:1. Many schools on the island — especially those in rural areas — have sat empty since the storm, and teachers’ unions on the island fear it could be paving the way for the kind of wholesale privatization that happened in New Orleans after Hurricane Katrina.

In a joint statement, Asociación de Maestros de Puerto Rico President Aida Diaz and American Federation of Teachers President Randi Weingarten slammed the plan. “High-quality public education is a crucial driver of economic growth and societal equity,” they write, “There are some positive aspects to the governor’s plan — the decision to halt debt payments for one. But to thrive, Puerto Rico needs to keep schools open, not close them, and that’s why the push for mass school closings falls wide of the mark.”

The University of Puerto Rico would also be subject to hundreds of millions of dollars in additional cuts.

Hundreds of millions of dollars in cuts to municipalities slated to take place this fall have been stalled, but would be reinstated pending approval of the plan, eventually scaling up to a total of $219.7 million by 2022. Additional cuts are planned for the Department of Corrections and to the island’s already beleaguered health care system, where the plan’s authors encourage “patient accountability and responsibility measures” and the establishment of “limits to benefits according to the actual needs of the beneficiaries and in alignment with market trends.”

While emphasizing the role of the private sector, the plan places almost superhuman faith in the capacity of market forces to satisfy the island’s most basic needs on every front from public safety to mass transit.

“Given Puerto Rico’s fiscal and economic conditions, it is expected for projects to carry certain risk premiums and have feasibility challenges,” its authors write. “However, the market recognizes well-structured projects, critical and transformative projects and has the ability to formulate innovative solutions to improve the financial profile of projects.” If we build a corporate-friendly economy, in other words, industry will come.

SAN ISIDRO, PUERTO RICO - DECEMBER 21: Young members of the extended Medina family eat dinner at dusk with light from a cell phone on December 21, 2017 in San Isidro, Puerto Rico. The community was hard-hit by Hurricane Maria and remains mostly without grid electricity. Barely three months after Hurricane Maria made landfall, approximately one-third of the devastated island is still without electricity. While the official death toll from the massive storm remains at 64, The New York Times recently reported the actual toll for the storm and its aftermath likely stands at more than 1,000. Puerto Rico's governor has ordered a recount as the holiday season approaches. (Photo by Mario Tama/Getty Images)
Young members of the extended Medina family eat dinner at dusk with light from a cellphone on Dec. 21, 2017 in San Isidro, Puerto Rico. Photo: Mario Tama/Getty Images

BECAUSE TOTAL ALLOCATIONS from the federal government for Puerto Rico haven’t yet been decided, the plan factors in a minimum of $35.3 billion in funds from Washington — about a third of the $94 billion minimum Caraballo Cueto, Stiglitz, and other economists estimate is needed. Getting much more won’t be easy. Aid to Puerto Rico factored relatively low on the priority list of both Democrats and Republicans alike in recent budget negotiations, and it’s unclear what kind of supplemental relief will be worked into the final version.
“In Puerto Rico today, there continues to be hundreds of thousands of people who still do not have electricity and clean drinking water. We must pass disaster relief right now which is adequate, which treats Puerto Rico and the Virgin Islands just as we will treat Texas and Florida,” Sanders said via email on upcoming budget talks. “We cannot continue to delay given the enormous suffering that exists in Puerto Rico and in the Virgin Islands.”

Warren’s office has been working on separate debt relief legislation for some time, a draft page of which — apparently co-sponsored by Sanders and Sen. Kirsten Gillibrand, D-N.Y. — was leaked late last week. Tentatively titled the “Territorial Relief Act of 2018,” the one-page summary outlines a path to debt relief for Puerto Rico and other U.S. territories: “The bill gives territories the option to terminate their debt obligations, much in the way U.S. cities and towns can do, if they meet certain stringent legal criteria,” while also compensating mainland-based creditors — individuals, pension funds and trade unions, for instance — with up to $15 million in federal funds. “Hedge funds and their investors, bond insurers, many financial firms with consolidated assets greater than $2 billion, repo or swaps” would be ineligible. The leaked file appears to be just the first page of a longer document.

While neither Sanders or Warren would comment on pending legislation, each agreed that Puerto Rico is deeply in need of debt relief. “Puerto Rico’s budget should go to rebuilding the island and addressing the ongoing humanitarian crisis. Not one cent should go to the vulture funds who snapped up their debt,” Warren told The Intercept.

Top photo: Mother Isamar holds her baby Saniel, 9 months, at their makeshift home, under reconstruction, after being mostly destroyed by Hurricane Maria, on Dec. 23, 2017 in San Isidro, Puerto Rico.

MEMBERS OF THE Puerto Rican diaspora have joined student activists and financial reform groups in a weeklong campaign to target university endowments profiting from Puerto Rican debt.

At Harvard University on Wednesday, the coalition called on the institution’s $37 billion endowment, the world’s largest, to divest from its $2 billion commitment with the Baupost Group. In October, The Intercept identified Baupost, a Boston-based hedge fund managed by billionaire Seth Klarman, as a large holder of one type of Puerto Rican debt. The fund had been hiding $911 million in COFINA bonds, a debt instrument backed by sales tax receipts, through a shell corporation named Decagon Holdings.

A disclosure last week from the COFINA bondholders said that Baupost’s investment had increased to $931 million. Klarman has consistently dismissed cries for debt cancellation for Puerto Rico, saying the island would be better off in the long run repaying its debts. Baupost bought the bonds on the cheap and would reap a huge payday if paid back at face value.

Klarman is a major GOP donor and supporter of the charter school movement; he is also an outspoken critic of President Donald Trump.

Bearing a large banner reading “Harvard Divest from Baupost,” hundreds of activists marched at Harvard Yard on Wednesday. Members of the Harvard Student Labor Action Movement participated in the protest, along with union groups, community organizers affiliated with the Center for Popular Democracy, and anti-hedge fund activists with the coalition Hedge Clippers.

A report issued by Hedge Clippers this week detailed how Harvard’s investment with Baupost was harming Puerto Rico. “Along with other vulture funds, [Baupost] is waging an aggressive campaign to force Puerto Rico to pay creditors — rather than pay for basic services or vital infrastructure,” the report states. “In other words, Baupost, on behalf of Harvard and other clients, is trying to get its hands on money that should be going toward a just recovery in Puerto Rico.”

The situation highlights the role college endowments play in propping up hedge funds, whose moneymaking strategies have often been criticized as anti-worker and predatory. According to Business Insider, one-third of all hedge fund assets under management come from endowments and public pension funds. Endowments had been limiting their exposure to hedge funds, due to disappointing returns and high fees, but that trend has slowed. Harvard’s endowment recently paused some of its investments in the fossil fuels industry, but would not commit to a full divestment.

Princeton ($995 million) and Yale ($710 million) currently have large investments in Baupost, according to filings with the IRS. Other colleges that have invested with Baupost in the past five years include Cornell, Barnard, Berklee College of Music, Brandeis, Clark University, Denison University, Holy Cross, Pomona, and the University of Chicago.

Julio López Varona, state director of Make the Road Connecticut and a leader in the Puerto Rico justice movement, told The Intercept that the coalition sent letters to all these universities urging them to divest. Only one of them, Yale University, responded, and they said the Baupost investment was ethically appropriate. “We decided that this was as good a time as ever to escalate our actions,” Varona said.

The coalition will be protesting at Yale on Thursday and the University of Phoenix, which is owned by Puerto Rican bondholders Apollo Education Group, on Friday. Related protests later this month will target Santander Bank, which played a key role in creating the debt instruments that spawned the crisis in Puerto Rico.

Harvard’s $2 billion commitment to Baupost is over 5 percent of its total endowment, an unusually large share. Based on the portion of Baupost’s assets invested in Puerto Rican bonds, Harvard could hold around $60 million in Puerto Rican debt through the investment.

Klarman is both an alumni and major donor to Harvard, which could explain the relationship. The Klarman Cell Observatory sits in Boston, courtesy a $32.5 million Klarman gift to the Eli and Edythe L. Broad Institute of Harvard and MIT in 2012. Klarman Hall, a conference center and performance space being built at the Harvard Business School, is slated for opening this fall.

A significant amount of Klarman’s funding comes from university endowments. “If we can get Harvard and Yale to divest, it will have a major impact on his portfolio,” said Varona.

“If we can get Harvard and Yale to divest, it will have a major impact on [Seth Klarman’s] portfolio”— Julio López Varona
Harvard has endorsed aid to Puerto Rico in the wake of Hurricane Maria, but the activists say this cannot square with how Harvard’s money is being put to use to immiserate the island’s citizens. Indeed, the island’s government and its fiscal control board has proposed $450 million in cuts over the next three years for its only public university, the University of Puerto Rico. That comes to nearly half the college’s total budget. Over 300 K-12 schools have already closed due to austerity measures.

Just this week, Puerto Rico Gov. Ricardo Rosselló announced plans to attempt to privatize the island’s electric power authority. Rosselló’s latest budget includes numerous austerity measures, but adds that the island will be unable to pay down debts over the next five years.

The Baupost Group declined to comment on the protest. Patrick McKiernan with Harvard Management Company, the university’s endowment, said it does not comment on specific investments. Yale has yet to respond to The Intercept, though it did tell the Boston Globe, “we continue to be aware of the situation and monitor it.”

Student-led university endowment divestment campaigns go back to the 1980s and anti-apartheid protests against South Africa. “There’s a lot of energy around this,” Varona said. “Many groups want to keep going.”

Top photo: Clients of Popular Bank of Puerto Rico wait in line at the Carolina Shopping Court branch to withdraw cash from their accounts after the passage of Hurricane Maria, in Carolina, Puerto Rico, on Sept. 27, 2017.

In Puerto Rico, a skirmish over how much debt the bankrupt island can handle

Spoiler:

The $16 billion aid package that Congress approved for Puerto Rico as part of the spending deal this month came as a relief to the territory’s government. It also came as a relief to its bondholders.

The price of Puerto Rican commonwealth bonds has soared since Congress passed the rescue package. Though the bankrupt territory has halted interest payments on its bonds, investors — including hedge funds — drove up the price of the general obligation bond due in 2035 by 11 percent on Feb. 14. The average price of the bond Friday was 32.01 cents on the dollar, up 26 percent for the week.

The source of investors’ hopes is a new Puerto Rican fiscal plan issued Feb. 12 that sharply raised the forecasts for cash flow and long-range sustainable debt that the territory had made before Congress acted. By fiscal 2023, the government will accumulate a $2.8 billion surplus, the plan predicts.

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But the stronger forecasts raised fears among some lawmakers that the federal funds — earmarked for Medicaid, housing reconstruction and other repairs after Hurricane Maria — would indirectly flow to Puerto Rico’s bondholders.

“We need to be unambiguously clear that the money Congress approved was for rebuilding Puerto Rico and to aid its citizens, not to line the pockets of Wall Street investors that bought the Island’s debt on the cheap,” Rep. Nydia M. Velázquez (D-N.Y.) said in a statement Friday. “It would be a moral outrage if money intended for Puerto Rico’s vulnerable was siphoned off to creditors and vulture funds.”

Velázquez and six other lawmakers wrote to the board created by the Puerto Rico Oversight, Management and Economic Stability Act to make sure the money from Congress is going to the right places.

At the same time, bondholders were not satisfied with the new fiscal plan. It “is built on sparse data and outright mischaracterizations,” said a group of creditors that includes bond insurers Ambac and MBIA, as well as other major institutions and individuals in Puerto Rico and on the mainland.

The oversight board must by law review the fiscal plan drawn up by the commonwealth government. Natalie Jaresko, the board’s executive director, would not comment on the prospects for a recovery for bondholders, except to say that “the capacity to pay can only exist with a growing economy.”

Jaresko said that the support from Congress would be “short-lived. It’s a couple of years. If you don’t use that cushion to make structural reforms, you would return to the economic decline trend pre-hurricane.”

She said that “the island must use the time and growth over the next couple of years . . . to make the changes required for Puerto Rico to come out of that much stronger, much more competitive.”

Some analysts said the changes in the fiscal plan did not mean that bondholders could expect a better deal. Any surplus could be used for further stimulus either through spending or tax cuts.

“Certainly, federal funds earmarked for recovery and reconstruction should not under any circumstances be utilized for debt service,” said Sergio Marxuach, public policy director for the Center for a New Economy, an independent Puerto Rican think tank. “ In theory, that surplus could be used to pay some debt service to bondholders,” but, he said, “it would be a big mistake to use that to service the debt. The number one priority should be to grow the economy, and any such surpluses should be directed to public investment.”

In the new fiscal plan, the Puerto Rican government raised the forecasts it had made less than three weeks earlier. Now it expects to have positive cash flow in as little as two years, topping $1 billion a year starting in 2020 — creating a target for bondholders eager to convince the bankruptcy court that the island can soon resume interest payments. Earlier, the commonwealth said it would not be able to restart interest payments for at least five years.

The new plan also says the battered island can sustain anywhere from $3.9 billion to $27 billion in debt, a figure that suggests owners of Puerto Rican government debt could escape with as little as a 45 percent “haircut” in the value of its bonds.

That is a much higher range than the Puerto Rican government estimated just 20 days earlier. Its Jan. 24 fiscal plan forecast sustainable debt ranging from roughly $2.5 billion to less than $15 billion — which would mean a much tougher deal for bondholders.

Marxuach said that an analysis by his center concludes that Puerto Rico should not pay any debt during the next five years and that the bankruptcy court should agree to wipe out 70 to 80 percent of outstanding debts.

The island’s creditors do not agree.

“Although every strained municipality would love to avoid paying its debts, Puerto Rico’s government cannot expect creditors to accept and trust a document built on fiscal metrics that are analytically flawed and completely inconsistent with historical precedent,” said a statement from the group of creditors that includes Ambac and MBIA. The group said that the fiscal plan was “completely lacking a foundation for revitalizing the local economy and restoring access to the capital markets.”

The fiscal plan applies only to the commonwealth and does not include the bankrupt Puerto Rico Electric Power Authority (PREPA), which on Thursday told a bankruptcy judge in New York that it was running out of money. U.S. District Judge Laura Taylor Swain initially rejected PREPA’s plea for a $1 billion loan from the island’s government.

On Friday, PREPA said it would activate an “operational emergency plan” that would slow the recovery from the power losses caused by the hurricane. About 20 percent of Puerto Ricans are still without electricity. On Monday, Swain approved a $300 million loan to avoid the curtailment of services.

Controversy is also simmering over who has ultimate authority over PREPA. The oversight board, concerned about corruption and bloated payrolls, wants to play a bigger role. So does an independent Puerto Rico Energy Commissioncreated in 2014. But Gov. Ricardo Rosselló wants to control the utility himself.

Last week Rosselló riled some of his congressional allies in Washington by drawing up plans to change the three-person energy commission into a one-person commission whose sole member could be dismissed by the governor without cause.

Members of Congress see the energy commission as akin to public service bodies on the mainland. Those have wide authority to protect consumers. Moreover, the recent financial aid package Congress passed calls on the Puerto Rico Energy Commission to oversee and audit the spending of federal money.

Although Rosselló has been at odds with the financial oversight board, the two are widely believed to be in agreement on downgrading the role of the energy commission.

A recent policy statement from the commission complained that the utility “in recent months has been resisting the commission’s authority — revealing a wish to return to the days of unregulated, politically influenced monopoly behavior that so ill-served the Commonwealth.”

SAN JUAN – Puerto Rico Treasury Secretary Raúl Maldonado said Friday that an evaluation of operations at the various government agency offices of finance and human resources began this week with the objective of identifying and implementing additional savings and spending reduction measures.

“In accordance with Executive Order 2017-033 of Governor Ricardo Rosselló, which establishes additional control measures for disbursements and expenses to comply with the Government’s Fiscal Plan, this week we assigned Department staff to several agencies in order to evaluate operations, also in accordance with Executive Orders 2017-01 and 2017-009,” he said in a written statement.

Maldonado, who is also the commonwealth’s chief financial officer, said the effort is intended to certify that all payroll payments made by Treasury and other dependencies are to staff that are confirmed to be working.

“We are seeking to optimize oversight of Human Resources in terms of assistance and [sick or vacation leaves], and therefore we are conducting an inventory of personnel. This is an initiative that is being worked on according to the powers that were granted to me by Governor Ricardo Rosselló as CFO, and that seeks to comply with the provisions of the Fiscal Plan,” he added.

The audits began with the Corrections & Rehabilitation, Family (and its dependencies), Transportation & Public Works, Health and Education departments. The teams comprise Treasury Internal Revenue and Internal Audit personnel.

Maldonado sent a letter to all the secretaries, directors and heads of government agencies requesting they provide the information required by the officials representing his Department, as well as instructing staff about the processes.

“This is the first time that the Department of the Treasury has carried out this supervision exercise and we intend it to be permanent, and we will validate that there be no undue charges,” he stressed.